Chairman
Boustany, Ranking Member Lewis, and Members of the Subcommittee, I thank you
for the opportunity to testify on the Internal Revenue Service’s administration
of refundable tax credits.

Refundable
credits were designed to help low-income individuals reduce their tax burden or
to provide incentives for other activities.The Earned Income Tax Credit (EITC), created in 1975, is used to offset
the impact of Social Security taxes on low-income families and to encourage
them to seek employment rather than welfare.[1]Prior to the enactment of the Taxpayer Relief Act of 1997,[2] the
tax law did not provide tax credits based solely on a taxpayer’s number of
dependent children.Congress then created
the Child Tax Credit and the Additional Child Tax Credit (ACTC) because the
individual income tax structure did not reduce tax liability enough to reflect
a growing family’s reduced ability to pay taxes as family size increased.In addition, the Congress further believed
that a tax credit for families with dependent children would reduce their
individual income tax burden, better recognize the financial responsibilities
of raising dependent children, and promote family values.[3]

More
recent refundable credits provide incentives for other activities, such as
buying a home, obtaining a college education, and adopting a child.The First-Time Homebuyer Credit (Homebuyer
Credit) was enacted to encourage home purchases to stimulate the weak housing
market.The American Opportunity Tax
Credit allows individuals to receive a credit for higher education expenses.The Adoption Credit[4]
allows individuals to offset qualified adoption expenses, making adoption
possible for some families who could not otherwise afford these expenses.

The
two largest refundable credits, the EITC and ACTC, receive a much larger appropriation
than the IRS’s own budget.For the 2011
Filing Season, the maximum EITC is $5,666; while the ACTC is generally limited
to 15 percent of earned income in excess of $3,000.[5]The appropriations for these credits in
Fiscal Year 2010 were $54.7 billion for the EITC and $22.7 billion for the ACTC.In contrast, the IRS’s total Fiscal Year 2012
budget request is $13.3 billion.

These
appropriations continue to grow as a result of recent legislative changes that have
increased the number of individuals eligible for the credit and the amount
individuals can claim.For example, the American Recovery and Reinvestment Act of
2009 (Recovery Act)[6]
temporarily increased for Tax Years[7] 2009
and 2010 the EITC percentage for individuals with three or more children from
40 to 45 percent of the individuals first $12,570 of earned income.Also, the income limit used for calculating
the credit was increased for married individuals filing a joint tax return.

In
addition, the Recovery Act temporarily increased the number of individuals
eligible for the credit by changing the income threshold for calculating the
ACTC for Tax Years 2009 and 2010.Prior
to the Congress enacting the Recovery Act, the ACTC would have been limited to
15 percent of earned income over $12,550.The Recovery Act changed this threshold to 15 percent of earned income
over $3,000.As such, more individuals were
eligible to claim the ACTC or a greater amount.

Although
each of these refundable credits provides benefits to individuals, the
unintended consequence of these credits is that they are often the targets of
unscrupulous individuals who file erroneous claims for these credits. In its June 14, 2010, report to TIGTA, the IRS
noted that they have found that refundable credits of significant amounts
attract fraud.[8]In particular, refundable tax credits present
an additional avenue for individuals to commit filing fraud.Nonrefundable tax credits are limited to the amount
of an individual's income tax liability. As such, the maximum benefit an individual
will receive if a nonrefundable credit is claimed inappropriately is to fully
offset his or her tax liability resulting in owing nothing. Refundable credits do not have such
limitations. In essence, individuals can
obtain money that they did not earn and to which they are not entitled simply
by claiming a refundable tax credit.Refundable
credits can result in tax refunds even if no income tax is withheld or paid;
that is, the credits can exceed the liability for the tax.

The
total amount of improper payments relating to refundable credits far exceeds
the amount of fraudulent tax refunds the IRS identifies and stops as part of
its Taxpayer Assurance Program.The IRS estimates
the improper payments for the earned income tax credit are between
$11 to $13 billion each year. The
IRS’s Taxpayer Assurance Program, formerly known as the Questionable Refund
Program, was set up to identify and stop fraudulent refunds.As of March 4, 2011, the IRS had identified
335,341 tax returns with $1.88 billion claimed in fraudulent refunds and
prevented the issuance of $1.82 billion (97 percent) of the fraudulent refunds
claimed.

I
will now discuss each of these refundable credits, providing improper payment
estimates and amounts when available; IRS actions to address these improper
payments; and recommendations we have made to reduce these payments.

Earned
Income Tax Credit – The IRS continues to report that 23 to 28 percent
of EITC payments are issued improperly each year.In Fiscal Year 2009, this equated to $11
to $13 billion in improper EITC payments.Although the IRS has annually reported billions in EITC improper
payments since it began reporting estimates to Congress in 2002, little
improvement has been made in reducing these payments.Executive Order 13520, signed by the
President on November 20, 2009, further increased agency accountability for
reducing improper payments and required the IRS to intensify its efforts and
set targets to reduce EITC improper payments.However, in the IRS’s June 14, 2010 report to us, the IRS did not
include required strategies or quantifiable targets to reduce EITC improper
payments.IRS management noted that
reduction targets were not set because it has to balance compliance and enforcement
resources among all income groups.

We
have conducted a number of audits that have identified opportunities to reduce
EITC improper payments. We have provided
the IRS with specific actions that could be taken to reduce improper payments
and allow the IRS to establish measurable reduction targets. While the IRS has implemented some of our
recommendations, it has not taken action to address key recommendations aimed
at preventing or reducing improper EITC payments. For example, we reported in December 2008 that
the IRS had developed processes to successfully identify billions of dollars in
erroneous EITC payments.However, the
IRS stated it did not have the resources to implement the processes that would
help address many of these cases, resulting in the majority of the improper claims
being paid.

We
recommended that the IRS develop alternative processes that are less costly
than audits to protect revenue associated with erroneous EITC claims at the
time a tax return is filed.[9]The IRS agreed with our recommendation,
noting that it was continuing its ongoing efforts to identify new alternatives
to address erroneous payments.The IRS acknowledged
that it cannot fully address EITC noncompliance by simply auditing returns and
must pursue alternatives to traditional compliance efforts.[10]However, the IRS has not made any significant
progress in developing and implementing these alternatives.This continues to hinder the IRS’s ability to
reduce the billions of dollars paid in erroneous EITC claims.

Furthermore,
the IRS does not require individuals to provide any supporting documentation to
verify eligibility for claiming the EITC.In a pilot project the IRS conducted from 2003 to 2006, it required
individuals to pre-certify eligibility for claiming the EITC, which included
providing specific documentation.This
documentation included third-party affidavits, letters on official letterhead
from a third party (generally community organizations, churches, etc.), and
official records such as school or medical records.At the completion of the pilot, the IRS
concluded that requesting this documentation created a burden on the taxpayer,[11]
even though this is the same documentation that the IRS requests from
individuals as part of EITC examinations.

Additional Child Tax Credit – In 2009, we reported
a significant increase in ACTC claims by filers who were unable to obtain a
Social Security Number or were not eligible to receive a Social Security
Number.[12]These individuals were not authorized to work
in the United States and filed tax returns using an Individual Taxpayer
Identification Number (ITIN).[13]The refundable credit claims made by these filers
have grown substantially.

For
Tax Year 2000, a total of 62,000 ITIN filers received $62 million in
ACTCs.This has since grown to 2.3
million ITIN filers claiming ACTCs totaling $4.2 billion in 2010.[14]This increase is due in part to changes in
the law which changed the eligibility criteria and calculation.Another reason for the increase in claims is
that a significant number of individuals are filing returns for multiple years to
obtain the ACTC for prior year tax returns (e.g.,
filing for Tax Years 2007, 2008, and 2009).In 2010, approximately 238,000 ITIN filers submitted over 608,000 tax
returns for multiple years and claimed just over $1 billion in ACTC on those tax
returns.Moreover, in our analysis of tax
returns processed in 2010, we found that some individuals have also submitted
duplicate tax returns for multiple years to multiple IRS processing centers and
received ACTC refunds.

Along
with the increase in claims for the ACTC, there has been an increased demand for
ITINs in order to file these returns.For
Fiscal Year 2011, the IRS estimates they will expend a significant amount of
resources to process over 2.2 million ITIN applications.[15]

Prior
to 1996, filers using an ITIN were entitled to claim the EITC.However, concerns were raised by the
Government Accountability Office, the IRS, and the Congress regarding
noncompliance with EITC requirements.The law was subsequently changed to deny the EITC to individuals who
file a tax return without a Social Security Number that is valid for
employment.[16]Specifically, the Personal Responsibility and Work Opportunity Reconciliation Act of 1996,[17]
prohibits individuals residing without authorization in the United States from
receiving most Federal public benefits as that term is defined in the Act.The Act also amended

26
U.S.C. § 32 (c) to require that claims for the credit be filed by taxpayers
using SSNsAs such, filers using an ITIN
are not eligible for the EITC.

The
change in the law prohibiting EITC to filers using an ITIN was made prior to
the creation of the ACTC and other refundable credits.However, the law also prohibits individuals
residing without authorization in the United States from receiving most Federal
public benefits, with the exception of certain emergency services and programs,
and defines a public benefit as:

Any grant, contract, loan, professional license, or
commercial license provided by an agency of the United States or by
appropriated funds of the United States; and any retirement, welfare, health,
disability, public or assisted housing, postsecondary [sic] education, food
assistance, unemployment benefit, or any other similar benefit for which
payments or assistance are provided to an individual, household, or family
eligibility unit by an agency of the United States or by appropriated funds of
the United States.[18]

The
current situation with the ACTC appears similar to that which preceded the
prohibition of the EITC to ITIN filers.Both the EITC and the ACTC are calculated based on a percentage of
earned income and both are refundable.Both are paid by an agency of the United States by appropriated
funds.Billions of dollars in ACTC are
being provided to ITIN filers without verification of eligibility, and IRS
employees have raised concerns about the lack of an adequate process for
identifying and addressing improper claims.[19]

IRS
management’s view is that the Personal
Responsibility and Work Opportunity Reconciliation Act of 1996 does not
provide sufficient legal authority for the IRS to disallow the ACTC to ITIN
filers.Currently the Internal Revenue
Code Title 26 U.S.C. section 24 does not require taxpayers to use a Social
Security Number to claim the credit and does not provide the IRS with math
error authority to deny the credit without an examination.[20]

As
such, legislation would be needed to clarify whether a Social Security Number
that is valid for employment is needed in order to claim the ACTC, consistent
with requirements for the EITC.If the
ACTC may not be paid, the IRS should be provided with math error authority to
disallow associated claims for the credits.We estimate that allowing the ACTC only to those filers who are eligible
to live and work in the United States (i.e.,
those with a Social Security Number that is valid for employment) would reduce
Federal outlays by approximately $4.2 billion annually.[21]

American Opportunity Tax
Credit – Also
as part of our Recovery Act oversight, we are in the process of completing a
review assessing the effectiveness of the IRS’s processes to identify erroneous
American Opportunity Tax Credit (AOTC) claims.The Recovery Act amended the Hope Scholarship Credit [22] to
allow a refundable tax credit —the AOTC.The AOTC allows individuals to receive a credit for higher education
expenses up to $2,500 per student per year for Tax Years 2009 and 2010, with up
to $1,000 being refundable.The IRS
requires no documentation to be provided to verify eligibility, including
whether an individual claimed as a student even attends a required accredited
educational institution.Our review is
identifying significant improper payments being made to taxpayers claiming the
credit and using ineligible students.[23]

Adoption Credit –The Adoption Credit was
changed to increase the amount from $12,150 to $13,170 and also made the
credit refundable.Recognizing that this
could increase the risk for erroneous claims, the IRS developed a strategy to attempt
to reduce this risk. As part of this
strategy, the IRS requires individuals to verify eligibility by attaching documentation
to their tax returns in support of an adoption.

However,our
analysis of the IRS’s Adoption Credit processing controls identified that, while
the IRS requires individuals to provide documentation that verifies their
eligibility, the IRS does not have the authority to deny the Adoption Credit if
the documentation is not provided.Without this math error authority, the IRS cannot deny the credit during
processing of the tax return, but must instead deny the credit post-processing
through the examination process, which is a much more costly, resource-intensive,
and burdensome process.

On October 29, 2010, we alerted IRS management
and recommended that they work with the Department of the Treasury to request from
Congress math error authority to deny Adoption Credit claims that lacked
documentation.The IRS did not agree
with this recommendation because it believed that it had developed and
implemented sufficient filters and compliance tools to handle potential Adoption
Credit fraud.This has resulted in a
significant number of Adoption Credit claims being sent to its post-processing
Examination function.As of April 28,
2011, the IRS has received 72,656 individual claims for more than $897 million
in Adoption Credits.Of these, 42,399
(58 percent) either had no required documentation or the documentation was
invalid or insufficient.According to
IRS procedures, each of these claims will be sent to the Examination function for
further review.

Math error authority to deny those claims
without required documentation at the time the tax return was processed would
have been less burdensome on individuals than post-processing examinations.Individuals would have been immediately notified
of the denial of the Adoption Credit.These individuals would have been informed that they can provide the IRS
with required documentation in response to the denial to support their
eligibility.If the individual provides
the IRS with required documentation supporting their eligibility for the
Adoption Credit the IRS has a goal to resolve these responses within 30 days of
receipt of the documentation.

In comparison, the IRS was unable to provide
an average timeframe for resolving Adoption Credit claims sent for
post-processing examinations.The IRS
will not have this information until the end of this fiscal year because of the
limited number of Adoption Credit examinations closed to date.However, the IRS estimates that an individual
would receive notification that documentation is needed to support eligibility
for claiming the Adoption Credit within three to four weeks after his or her tax
return is received in the Examination function.The individual then has 30 days to respond to the IRS’s request for
required documentation.Once the IRS
receives the information, the IRS does not have a specific time goal for
closing the case subsequent to receipt of the information.

Homebuyer Credit – As part of our
Recovery Act oversight, we addressed the IRS’s administration of the Homebuyer
Credit.The Worker, Homeownership, and Business Assistance Act of 2009[24]
revised, extended, and expanded the Homebuyer Credit allowed by previous acts to
a broader range of home purchases and added new documentation
requirements.For example, residents of
the same main home for at least five years may claim the Homebuyer Credit if
they purchase new principal residences.In
Processing Years 2009 and 2010, the IRS reported issuing Homebuyer Credits of
more than $12.3 billion and $13.7 billion, respectively.

We recommended that the IRS
require taxpayers to supply documentation with their tax return to substantiate
a home purchase.IRS management
initially responded that such a requirement would be burdensome for individuals
and the IRS. Nonetheless,
the burden of providing documentation to substantiate such a credit is no
greater than the burden placed on individuals receiving payments from other Federal
Government agencies and on the agencies providing those payments. For example, to receive food stamps,
individuals are required to provide identification such as a driver’s license,
State identification, birth certificate, or alien card; proof of income; proof
of amounts spent on child care; rent receipts or proof of mortgage payments; records
of utility costs; and medical bills for certain household members.

The IRS also stated that
it did not have math error authority to disallow the Homebuyer Credit during tax
return processing even if it did ask for documentation but none was
provided.The IRS initially took no
steps to obtain this math error authority.After the issuance of TIGTA’s first interim report on that credit,[25] Congress passed
legislation requiring documentation for the Homebuyer Credit and providing the
IRS with math error authority to disallow the credit if the documentation was
not provided.[26]In response to our report, the IRS required
taxpayers claiming the credit after November 6, 2009, to attach a copy of their
Form HUD-1, U.S. Department of Housing and Urban Development Settlement
Statement, to support their claim.The documentation
requirements meant that individuals claiming the Homebuyer Credit had to file a
paper tax return and could not electronically file their tax return.The IRS indicated that its current electronic
filing system was not able to handle the wide variety of required and
recommended supporting documents that would have to be scanned and
submitted.

A significant number of
erroneous claims of the Homebuyer Credits were processed prior to
implementation of the documentation requirements.Overall, we estimate that at
least $485 million of the more than $513 million in potentially erroneous
claims we identified were issued with no IRS scrutiny, such as an examination
or steps to validate the claim. These erroneous credits
might have been denied if documentation requirements were in place.

Based
on our review of the various refundable credits, we believe the IRS should
require individuals to provide documentation to support eligibility for all
refundable tax credits.If such
documentation is required, the IRS will also need math error authority to deny
refundable credits when supporting documentation is not provided.

As
with the Homebuyer Credit, the IRS requires individuals claiming an Adoption
Credit to file a paper tax return.However, the IRS’s Modernized e-File System is replacing the IRS’s existing
electronic filing system with a new modernized, Internet-based system that has
the capability of allowing individuals to scan and attach documents to their
tax returns.The IRS first began
receiving a limited number of tax returns through the Modernized e-File System
in Processing Year 2010 and expects full migration in Processing Year
2012.The ability to attach supplemental
information to an electronic tax return will reduce the need for the IRS to require
individuals to file paper tax returns.

We
at TIGTA take seriously our mandate to provide independent oversight of the IRS
in its administration of the Nation’s tax system.I hope my discussion of refundable credits helps
the Congress to ensure accountability of the IRS and assists you with your
oversight duties.

Chairman
Boustany, Ranking Member Lewis, and Members of the Subcommittee, thank you for
the opportunity to share my views.

[5] The ACTC is the refundable portion of
the Child Tax Credit.This credit phases
out for taxpayers depending upon their income level.Taxpayers with earned income of less than
$3,000 may be eligible for a refundable credit if they have three or more
qualifying children and have paid Social Security taxes that exceed their EITC.

[9]The
Earned Income Tax Credit Program Has Made Advances; However, Alternatives to
Traditional Compliance Methods Are Needed to Stop Billions of Dollars in
Erroneous Payments (Reference Number 2009-40-024, dated December 31, 2008).

[13] An ITIN is available to individuals
who are required to have a taxpayer identification number for tax purposes, but
do not have and are not eligible to obtain a Social Security Number because
they are not authorized to work in the United States.

[14]Budget
Hearing with the Treasury Inspector General for Tax Administration, Hearing
Before the H.Comm. on Appropriations,
Subctm. on Financial Services and General Government,112th
Cong. (Apr. 15, 2011) (statement of J. Russell George).

[15] ITIN processing uses the full time
equivalent of 463 IRS employees.

[16] The Social Security Administration
will issue a Social Security card that notes “NOT VALID FOR EMPLOYMENT” to
individuals from other countries who:(1) are lawfully admitted to the United States without work authorization
but with a valid non-work reason for needing a Social Security Number or
(2) need a number because of a State or Federal law requiring a Social
Security Number to obtain benefits to which an individual has already
established entitlement.

[19]Actions
Are Needed to Ensure Proper Use of Individual Taxpayer Identification Numbers
and to Verify or Limit Refundable Credit Claims (Reference Number 2009-40-057,
dated March 31, 2009).

[20] Math error authority statutorily
allows the IRS to correct tax return errors during processing, including
calculation errors and entries that are inconsistent or exceed statutory limits
and assess additional tax without using deficiency procedures.

[21] Changes made to the ACTC in the
Recovery Act are effective through Tax Year 2012.If no further changes are made, the
eligibility requirements revert to previous levels and would result in fewer
individuals qualifying for the ACTC.

[22] The Hope Credit was included as part
of the Taxpayer Relief Act of 1997, and was established to assist middle-class
families with the costs
associated with a college
degree. The credit is set forth at 26 U.S.C. § 25A
(a).

[23] An eligible student must be enrolled
in a program that leads to a degree, certificate, or other recognized
educational credential, and be enrolled at least half time for at least one
academic period during the year.Students are not eligible if they have already completed the first four years
of post-secondary education or if they have been convicted of a felony for
possessing or distributing a controlled substance.